Jowler Creek Vineyard and Winery: Uncorking Sustainable Growth in the Boutique Wine Industry Michelle Mullins Santiago Assistant Professor Department of Agricultural and Industrial Sciences Sam Houston State University [email protected] Michael Sykuta Associate Professor Department of Agricultural Economics University of Missouri [email protected] Prepared for the 2009 AAEA Graduate Student Section Case Study Competition Milwaukee, WI July 26‐27, 2009 Copyright © 2009 by Michelle Mullins Santiago and Michael Sykuta. All rights reserved. Readers may make verbatim copies of this document for non-commercial purposes by any means, provided that this copyright notice appears on all such copies. Introduction On a Saturday morning late this spring, Colleen and Jason Gerke, owners and operators of Jowler Creek Winery, could be found walking together through their vineyards toward their tasting facility. They were reflecting on how quickly the past year had flown by; their winery was officially three years old, their tasting room facility would soon be celebrating its first birthday, their newest wine “Butterfly Blush” was a 2008 award‐winning wine, and they would soon be releasing their newest batch of Vignoles wine to retailers. While the Gerke’s were thrilled with the growth and success the winery had been achieving, they were also pensive; how could they continue to surpass the level of success they had, but maintain the winery’s focus on product quality and sustainability, especially given the tumultuous economic outlook and the ever changing regulatory environment of the United States wine industry ? Whatever the solution, they concluded, “We have to maintain the quality of our wines. We have to focus on getting the most flavor in every glass. And we have to do it in a way that is sustainable for the environment and for our family.” Wineries in the United States A Growing Commodity The past 30 years have seen an explosion in wine consumption and the number of wineries in the United States. According to The Wine Institute (www.wineinstitute.org), U.S. wine consumption per capita increased from 1.98 gallons in 1979 to 2.47 gallons in 2008. Total U.S. wine consumption increased from 325 million to 753 million gallons over the same period. As a result, in 2008 the U.S. passed Italy to become the second largest wine market in the world, although per capita consumption in the US is still very low relative to other countries (not even in the top 50). Interest in wine extends well beyond the glass. The wine industry is a focal point for agritourism in the U.S. Acres of neatly trimmed vineyards, tours of wine production facilities, and visits to tasting 1 rooms and a chance to learn first‐hand from the wines’ makers have turned into a thriving niche market for tourism in wine producing regions. A 2007 report by the wine research group MKF Research reported that the wine industry generated 27.5 million wine‐related tourist visits annually, contributing $3 billion in wine tourism expenditures to the U.S. economy. As interest in wine has increased, so has the number of wineries. The 1974 issue of Wines & Vines Annual Buyer’s Guide listed 800 wineries operating in 34 states. The February 2009 issue of Wine Business Monthly (McKenney, 2009) reported just over 5000 bonded wineries in the US, with wineries located in all 50 states. Although the number of wineries has grown substantially, the vast majority of wine is produced by a relatively small number of large wineries. Wine Business Monthly reported that the 30 largest wineries in 2008 represent more than 90% of the US wine market by volume. The largest, E&J Gallo, produced 67 million cases (almost 160 million gallons) while the smallest of the top 30, Rutherford Wine Co., produced 380,000 cases (just over 900,000 gallons). The Missouri Wine Industry Missouri has a long tradition of wine production, going back to the early German settlers along the Missouri River in the mid‐1800s. Prior to Prohibition, Missouri was the second largest wine producing state in the nation, producing over two million gallons annually. The industry was reborn in the 1960s, when several of the original wineries were restored and brought into production. Over the past 25 years, the number of wineries has grown from 25 to approximately 90 bonded wineries, and Missouri has four recognized American Viticultural Areas (AVA). In‐state sales of Missouri wine have doubled in the past decade, growing from roughly 387,600 thousand gallons in 1998 to just over 837,000 gallons in 2007. This growth represents an increase in market share among Missouri wine consumers. Missouri wine market share increased from 5% in 1998 to over 7.5% of wine consumed in Missouri in 2007. As is the case nationally, production is highly concentrated among 2 the largest producers, with just two wineries producing almost 54% of production by volume. Almost seventy percent of Missouri wineries produce less than 5,000 gallons; 22 wineries produce less than 1000 gallons each. Wine also contributes significantly to Missouri’s tourism industry. Research sponsored by the Missouri Wine & Grape Growers Association estimated there were 812,000 wine‐related tourist visits in 2007, generating wine‐related tourism expenditures of almost $203 million. Legal Environment of Wine The 21st Amendment, which repealed Prohibition, also granted states control of their own alcohol industries. Of the Amendment’s three sections, the first repealed Prohibition, and is often most familiar to general consumers. The second, though, provided each state with the right to regulate its own alcohol beverage industry, and is the section most often considered by those producers and middlemen of the industry. The states’ regulatory rights of control have been applied to all links of the supply chain and include the taxation and temperance rights. Although each state implemented their 21st Amendment regulatory rights differently, three distinct types of distribution systems emerged: state‐operated distribution, private sector three‐tiered distribution; and outright bans on alcohol. State‐wide bans ended with Mississippi in 1966, leaving state‐operated and three‐ tier distribution systems as the two forms observed today. State‐operated distribution systems involve state ownership of wholesale and, to some extent, retail alcohol sales, though some states opt to franchise operation of outlets at one or more levels to private contractors. States with state‐controlled distribution systems are called control states or “monopoly states” and include Alabama, Idaho, Michigan, Mississippi, Montana, New Hampshire, North Carolina, Ohio, Oregon, Pennsylvania, Utah, Vermont, Virginia, Washington, and West Virginia. 3 Three‐tiered distribution systems regulate the influence that parties at one stage of the value chain can exert on other stages by prohibiting integration between alcohol producers, wholesalers, and/or retails and by requiring retailers to make their purchases through licensed wholesalers and not directly from producers. 1 Most states operate a three‐tier distribution system, requiring participants at each stage of the value chain to obtain operating licenses or permits issued by the state’s Alcohol Beverage Control board (“ABC”). In addition to prohibiting integration, states also use the three‐tiered system and permitting standards to implement other regulations including price posting, advertising, and restrictions on sites of sale and franchise laws.2 The purpose of the three‐tier system is argued as a means to limit producers’ power to influence lower retail prices in order to increase quantity demanded, as increased demand presumably increases the occurrence of negative externalities associated with increased consumption.3 Although states require licensing and/or permit systems for firms in the industry, the number of producers and distributors has changed. As beer and wine have gradually become more popular the number of wineries and breweries have increased, especially the number of small wineries and microbreweries. The number of specialty brewers in the US increased from 37 in 1985 to 1552 in 2006, similar to the rate of growth in wineries described above. Growth has also been a trend in distribution; however it has been growth regarding firm size, not number of firms. Distributor consolidation in each alcohol segment in the last 20 years has led to a sizable reduction in the number of distributors per state, especially in the wine and spirits segments, and has led to an increase in the power of the national and regional distributors that have emerged. For example, the 1 Some states allow producers to own interest in some kinds of distribution outlets, but the interest is not supposed to be controlling. California allows brewers to hold ownership interest in distribution outlets although this is prohibited in other states. 2 There are a multitude of other regulations that states implement including standards on container sizes, production methods, and ingredient labeling. These regulations are standard legislation in other agricultural industries and are not unique to the three-tier distribution system. 3 This reasoning is commonly cited in the literature for increased taxation and industry protection in each state although Reikhof and Sykuta (2005) show direct shipment laws were enacted for economic protection. 4 number of beer distributors has decreased from 4181 in 1985 to 2036 in 2006, while the number of wine distributors has decreased from 953 in 1983 and 733 in 2006. These changes in industry structure have skewed market and contract power in favor of distributors and make it especially difficult for wineries to market to consumers. As most wineries are small, they are not able to produce large enough quantities that would make national (or even regional) distribution feasible. Additionally, as the ratio of distributors to wineries is very small, distributors effectively have a large pool of wine producers or brands from which to select.